10-Q Q1 2018

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2018

[  ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______ to _______

Commission file number 000-27507

CYNERGISTEK, INC.

(Exact name of registrant as specified in its charter)

Delaware

37-1867101

(State or other jurisdiction of
incorporation or organization)

(I.R.S. Employer
Identification No.)

27271 Las Ramblas, Suite 200

Mission Viejo, California  92691

(Address of principal executive offices, zip code)

(949) 614-0700

(Issuer’s telephone number)

N/A
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ  No o.

Indicated by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ No o.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer oAccelerated filer o

Non-accelerated filer oSmaller reporting company þ

Emerging growth company  ¨

Indicate by check mark whether the registrant is a shell company (as defined by Section 12b-2 of the Exchange Act).  Yes o No þ.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standard provided pursuant to Section 13(a) of the Exchange Act.

The number of shares of the issuer’s common stock, $0.001 par value, outstanding as of May 11, 2018 was 9,616,133.




CYNERGISTEK, INC.

FORM 10-Q

TABLE OF CONTENTS

Page

PART I – FINANCIAL INFORMATION

Item 1.

Financial Statements

Condensed Consolidated Balance Sheets
as of March 31, 2018 (unaudited) and December 31, 2017

3

Condensed Consolidated Statements of Operations
for the Three Months Ended March 31, 2018 and 2017 (unaudited)

4

Condensed Consolidated Statement of Stockholders’ Equity
for the Three Months Ended March 31, 2018 (unaudited)

5

Condensed Consolidated Statements of Cash Flows
for the Three Months Ended March 31, 2018 and 2017 (unaudited)

6

Notes to Condensed Consolidated Financial Statements (unaudited)

8

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

20

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

27

Item 4.

Controls and Procedures

27

PART – II – OTHER INFORMATION

Item 1a.

Risk Factors

28

Item 6.

Exhibits

29

Signatures

30


2



PART I – FINANCIAL INFORMATION

ITEM 1.   FINANCIAL STATEMENTS.

CYNERGISTEK, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

March 31, 2018 (unaudited)

December 31, 2017

ASSETS

Current assets:

Cash and cash equivalents

$3,409,293 

$4,252,060 

Accounts receivable, net

10,577,287 

13,264,323 

Prepaid and other current assets

1,590,277 

557,426 

Supplies

1,085,762 

1,156,006 

Total current assets

16,662,619 

19,229,815 

Property and equipment, net

766,476 

831,784 

Deposits

87,778 

87,376 

Deferred income taxes

3,350,310 

3,120,310 

Intangible assets, net

10,448,190 

10,900,924 

Goodwill

18,525,206 

18,525,206 

Total assets

$49,840,579 

$52,695,415 

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:

Accounts payable and accrued expenses

$5,171,719 

$9,631,634 

Accrued compensation and benefits

2,715,474 

3,711,551 

Deferred revenue

1,035,470 

1,425,821 

Note payable

343,750 

Current portion of long-term liabilities

3,130,230 

5,494,837 

Total current liabilities

12,396,643 

20,263,843 

Long-term liabilities:

Term loan, less current portion

14,676,081 

9,438,333 

Promissory notes to related parties, less current portion

5,437,500 

6,000,000 

Capital lease obligations, less current portion

124,392 

147,861 

Total long-term liabilities

20,237,973 

15,586,194 

Commitments and contingencies

Stockholders’ equity:

Common stock, par value at $0.001, 33,333,333 shares authorized, 9,592,547 shares issued and outstanding at March 31, 2018 and 9,576,028 shares issued and outstanding at December 31, 2017

9,593 

9,576 

Additional paid-in capital

31,344,607 

31,156,362 

Accumulated deficit

(14,148,237)

(14,320,560)

Total stockholders’ equity

17,205,963 

16,845,378 

Total liabilities and stockholders’ equity

$49,840,579 

$52,695,415 

The accompanying notes are an integral part of these condensed consolidated financial statements.


3



CYNERGISTEK, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

Three Months Ended March 31,

2018

2017

Net revenues

$16,383,317 

$18,254,689 

Cost of revenues

12,237,865 

13,667,541 

Gross profit

4,145,452 

4,587,148 

Operating expenses:

Sales and marketing

1,499,047 

1,369,008 

General and administrative expenses

2,635,547 

2,174,435 

Depreciation

91,583 

91,224 

Amortization of acquisition-related intangibles

452,734 

520,343 

Total operating expenses

4,678,911 

4,155,010 

(Loss) income from operations

(533,459)

432,138 

Other income (expense):

Other income

19 

19 

Interest expense

(403,461)

(412,334)

Total other income (expense)

(403,442)

(412,315)

(Loss) Income before provision for income taxes

(936,901)

19,823 

Income tax benefit (expense)

229,558 

(13,539)

Net (loss) income

$(707,343)

$6,284 

Net (loss) income per share:

Basic

$(0.07)

$0.00 

Diluted

$(0.07)

$0.00 

Number of weighted average shares outstanding:

Basic

9,586,608 

9,216,719 

Diluted

9,586,608 

9,615,285 

The accompanying notes are an integral part of these condensed consolidated financial statements.


4



CYNERGISTEK, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

THREE MONTHS ENDED MARCH 31, 2018

(UNAUDITED)

Additional

Total

Common Stock

Paid-in

Accumulated

Stockholders’

Shares

Amount

Capital

Deficit

Equity

Balance at December 31, 2017

9,576,028

$9,576

$31,156,362 

$(14,320,560)

$16,845,378 

Stock compensation expense for options and warrants granted to employees and directors

-

-

11,516 

11,516 

Stock compensation expense for restricted stock units granted to employees

-

-

176,746 

176,746 

Stock options exercised

16,519

17

(17)

Cumulative effect of adoption of revenue recognition standard ASC 606

-

-

879,666 

879,666 

Net loss

-

-

(707,343)

(707,343)

Balance at March 31, 2018

9,592,547

$9,593

$31,344,607 

$(14,148,237)

$17,205,963 

The accompanying notes are an integral part of these condensed consolidated financial statements.


5



CYNERGISTEK, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

Three Months Ended March 31,

2018

2017

Cash flows from operating activities:

Net (loss) income

$(707,343)

$6,284  

Adjustments to reconcile net (loss) income to net cash provided by (used for) operating activities:

Depreciation

91,583 

91,224  

Amortization of intangible assets

452,734 

520,343  

Deferred income taxes

(230,000)

-  

Bad debt recoveries

(13,469)

-  

Stock compensation expense for warrants and options granted to employees and directors

11,516 

24,659  

Stock compensation expense for restricted stock units granted to employees and directors

176,746 

-  

Note payable issued in consideration for severance pay

343,750 

-  

Interest expense related to loan acquisition costs

1,617 

-  

Changes in operating assets and liabilities:

Accounts receivable

2,700,505 

(633,273)  

Supplies

70,244 

68,707  

Prepaid and other current assets

(153,185)

769,404  

Deposits

(402)

(45,854)  

Accounts payable and accrued expenses

(709,915)

(1,030,525)  

Accrued compensation and benefits

(996,077)

(1,293,876)  

Deferred revenue

(390,351)

(146,948)  

Net cash provided by (used for) operating activities

647,953

(1,669,855)  

Cash flows from investing activities:

Purchases of property and equipment

(26,275)

(152,177)  

Amount paid to purchase CynergisTek, net of cash received

(13,448,521)  

Net cash used for investing activities

(26,275)

(13,600,698)  

Cash flows from financing activities:

Proceeds from term loan

17,250,000 

14,000,000  

Loan acquisition fees paid

(111,250)

-  

Payments on term loans

(11,818,333)

(1,646,667)  

Payments on promissory notes to related parties

(6,750,000)

-  

Payments on capital leases

(34,862)

(43,890)  

  Proceeds from issuance of common stock through stock options and warrants

32,665  

Net cash (used for) provided by financing activities

(1,464,445)

12,342,108  

Net decrease in cash and cash equivalents

(842,767)

(2,928,445)  

Cash and cash equivalents, beginning of period

4,252,060 

6,090,844  

Cash and cash equivalents, end of period

$3,409,293 

$3,162,399  

The accompanying notes are an integral part of these condensed consolidated financial statements.


6



CYNERGISTEK, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

(UNAUDITED)

Three Months Ended March 31,

2018

2017

Supplemental disclosure of cash flow information:

Interest paid

$644,895

$198,416

Income taxes paid

$20,262

$1,950

Non-cash investing and financing activities:

Property and equipment acquired through capital leases

$-

$110,657

Common stock issued in connection with the acquisition of CynergisTek, Inc.

$-

$2,772,000

Promissory notes issued in connection with the acquisition of CynergisTek, Inc.

$-

$9,000,000

Fair value of earn-out liability in connection with the acquisition of CynergisTek, Inc.

$-

$2,356,000

The accompanying notes are an integral part of these condensed consolidated financial statements.


7



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

THREE MONTHS ENDED MARCH 31, 2018 AND 2017

(UNAUDITED)

1.BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements of Cynergistek, Inc. and its subsidiaries (the “Company”, “we”, “us” or “Cynergistek”) have been prepared in accordance with generally accepted accounting principles of the United States of America (“GAAP”) for interim financial statements pursuant to the rules and regulations of the Securities and Exchange Commission.  Accordingly, these financial statements do not include all of the information and notes required by GAAP for complete financial statements.  These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017, as filed with the Securities and Exchange Commission (“SEC”) on March 28, 2018.

The unaudited condensed consolidated financial statements included herein reflect all adjustments (which include only normal, recurring adjustments) that are, in the opinion of management, necessary to state fairly our financial position and results of operations as of and for the periods presented.  The results for such periods are not necessarily indicative of the results to be expected for the full year.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  As a result, actual results could differ from those estimates.

The accompanying unaudited condensed consolidated financial statements include the accounts of Cynergistek and its wholly owned subsidiaries.  All intercompany balances and transactions have been eliminated.

Based on the Company’s recent integration with CTEK Security and an analysis of how our Chief Operating Decision Makers review, manage and are compensated, we have determined that the Company operates in two segments, services and equipment & software resale.  The equipment & software resale operating segment is not reported separately in the accompanying condensed consolidated financial statements, as this segment did not meet the quantitative thresholds established in ASC 280-10-50-12, For the periods presented, all revenues were derived from domestic operations.

As described in more detail in our Current Report on Form 8-K filed with the Securities and Exchange Commission on September 8, 2017, Auxilio, Inc., a Nevada corporation (“Auxilio”) changed its name and state of incorporation from the State of Nevada to the State of Delaware by merging (the “Reincorporation”) with and into its wholly-owned subsidiary, CynergisTek, Inc., a Delaware corporation, which was established for the purpose of the Reincorporation.   As a result of the Reincorporation, Auxilio ceased to exist as a separate entity.  As of the date of the merger, each outstanding share of Auxilio’s common stock was deemed, by operation of law, to represent the same number of shares of our common stock.  In accordance with Rule 12g-3 under the Securities Exchange Act of 1934, as amended, the shares of our common stock were deemed to be registered under Section 12(b) of the Exchange Act as a successor to Auxilio.  Effective as of September 8, 2017, the Company’s trading symbol changed to “CTEK.”  

As part of the Reincorporation, two wholly owned subsidiaries of the Company also changed their corporate names, as follows: (i) Auxilio Solutions, Inc., a California corporation, has changed its name to CTEK Solutions, Inc.; and (ii) CynergisTek, Inc., a Texas corporation, has changed its name to CTEK Security, Inc. (“CTEK Security”).  

We have performed an evaluation of subsequent events through the date of filing these unaudited condensed consolidated financial statements with the SEC.


8



2.RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In May 2014, the FASB issued guidance which provides a single, comprehensive accounting model for revenue arising from contracts with customers (“Topic 606”). This guidance supersedes most of the existing revenue recognition guidance, including industry-specific guidance. Under this model, revenue is recognized at an amount that a company expects to be entitled to upon transferring control of goods or services to a customer, as opposed to when risks and rewards transfer to a customer. The new guidance also requires additional disclosures about the nature, timing and uncertainty of revenue and cash flow arising from customer contracts, including significant judgments and changes in judgments. Considering the one-year delay in the required adoption date for the guidance as issued in July 2015, the new guidance is effective for us beginning in 2018 and may be applied retrospectively to all prior periods presented or through a cumulative adjustment to the opening retained earnings balance in the year of adoption. We adopted this standard beginning January 1, 2018 and are using the modified retrospective method of adoption. Under the new guidance, based on the nature of our contracts, we will continue to recognize revenue in a similar manner as with the current guidance. Additionally, the unit of accounting, that is, the identification of performance obligations, is consistent with current revenue guidance. Accordingly, the adoption of this standard did not significantly impact our revenues.

In February 2016, the FASB issued a new accounting standard on leasing. The new standard will require companies to record most leased assets and liabilities on the balance sheet, and also proposes a dual model for recognizing expense. This guidance will be effective in the first quarter of 2019 with early adoption permitted. We have evaluated the impact of adopting this guidance and we are preparing for the changes to be made to our consolidated financial statements. We expect the adoption of these accounting changes will materially increase our assets and liabilities but will not have a material impact on our net income or equity.

In January 2017, the FASB issued a new accounting standard simplifying the test for goodwill impairment. Currently, the fair value of the reporting unit is compared with the carrying value of the reporting unit (identified as “Step 1”). If the fair value of the reporting unit is lower than its carrying amount, then the implied fair value of goodwill is calculated. If the implied fair value of goodwill is lower than the carrying value of goodwill an impairment is recognized (identified as “Step 2”). The new standard eliminates Step 2 from the impairment test; therefore, a goodwill impairment will be recognized as the difference of the fair value and the carrying value. The new standard becomes effective on January 1, 2020 with early adoption permitted. We are currently evaluating the impact that the new standard will have on our financial position, results of operations and cash flows.

In August 2016, the FASB issued new accounting standard which is intended to reduce the existing diversity in practice in how certain cash receipts and cash payments are classified in the statement of cash flows. This guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years with early adoption permitted, provided that all of the amendments are adopted in the same period. We are currently evaluating the impact of adopting this standard on our consolidated financial statements.

In January 2017, the FASB issued new accounting standard which clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions or disposals of assets or businesses. This guidance will be effective for the Company for the year ending December 31, 2019 and interim reporting periods within that year. Early adoption is permitted for transactions that have not been reported in financial statements that have been issued or made available for issuance. We are currently evaluating the effect of the adoption of this guidance on our consolidated financial statements.

In May 2017, the FASB issued new accounting standard which provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in ASC Topic 718. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. This guidance will be effective for the year ending December 31, 2019 and interim reporting periods within that year. Early adoption is permitted. We expect the adoption of this guidance will not have a material effect on our consolidated financial statements or footnotes.


9



3.REVENUES

On January 1, 2018, we adopted Topic 606 using a modified retrospective method applied to those customer contracts which were not completed as of January 1, 2018. There was no change in revenues reported using this method as compared to the previous guidance. Below is a summary of our revenues disaggregated by revenue source.

Three Months Ended March 31,

2018

2017

Managed services

$13,340,944

$15,800,427

Consulting and professional services

2,019,854

1,257,136

Office equipment, hardware and software resales

1,022,519

1,197,126

Net revenues

$16,383,317

$18,254,689

4.OPTIONS, WARRANTS AND RESTRICTED STOCK UNITS

Below is a summary of stock option, warrant and restricted stock activity during the three-month period ended March 31, 2018:

Options

Shares

Weighted Average Exercise Price

Weighted Average Remaining Term in Years

Aggregate
Intrinsic Value

Outstanding at December 31, 2017

724,400 

$3.09

Granted

-

Exercised

(16,519)

2.75

Cancelled

(33,659)

3.34

Outstanding at March 31, 2018

674,222 

$3.15

4.05

$1,295,077

Exercisable at March 31, 2018

620,438 

$3.10

4.05

$1,185,334

Warrants

Shares

Weighted Average Exercise Price

Weighted Average Remaining Term in Years

Aggregate
Intrinsic Value

Outstanding at December 31, 2017

77,779

$3.03

Granted

-

-

Exercised

-

-

Cancelled

-

-

Outstanding at March 31, 2018

77,779

$3.03

4.80

$151,659

Exercisable at March 31, 2018

77,779

$3.03

4.80

$151,659


10



Restricted Stock Units

Shares

Weighted Average Price

Weighted Average Remaining Term in Years

Outstanding at December 31, 2017

506,500 

$3.35

Granted

-

Exercised

-

Cancelled

(6,000)

2.76

Outstanding at March 31, 2018

500,500 

$3.35

2.46

For the three months ended March 31, 2018 and 2017, stock-based compensation expense recognized in the consolidated statements of operations as follows:

Three Months

Ended March 31,

2018

2017

Cost of revenues

$32,332

$13,955

Sales and marketing

57,490

182

General and administrative expense

98,440

10,522

Total stock-based compensation expense

$188,262

$24,659

5.NET (LOSS) INCOME PER SHARE

Basic net (loss) income per share is calculated using the weighted average number of shares of our common stock issued and outstanding during a certain period and is calculated by dividing net (loss) income by the weighted average number of shares of our common stock issued and outstanding during such period. Diluted net (loss) income per share is calculated using the weighted average number of common and potentially dilutive common shares outstanding during the period, using the as-if-converted method for secured convertible notes, and the treasury stock method for options and warrants. Diluted net (loss) income per share does not include potentially dilutive securities because such inclusion in the computation would be anti-dilutive.

For the three months ended March 31, 2018, potentially dilutive securities consisted of options and warrants to purchase 280,416 shares of common stock at prices ranging from $0.90 to $6.45 per share and 500,500 shares of restricted stock units. Of these potentially dilutive securities, none of the shares to purchase common stock from the options and warrants or shares related to the restricted stock units are included in the computation of diluted earnings per share because the effect of including these instruments would be anti-dilutive.

For the three months ended March 31, 2017, potentially dilutive securities consisted of options and warrants to purchase 1,454,051 shares of common stock at prices ranging from $0.90 to $6.45 per share. Of these potentially dilutive securities, 398,566 of the shares of common stock underlying the options and warrants are included in the computation of diluted earnings per share because the effect of including the remaining instruments would be anti-dilutive.


11



Three Months Ended March 31,

2018

2017

Numerator:

Net (loss) income

$(707,343)

$6,284

Denominator:

Denominator for basic calculation weighted average shares

9,586,608

9,216,719

Dilutive common stock equivalents:

Options and warrants

398,566

Denominator for diluted calculation weighted average shares

9,586,608

9,615,285

Net income per share:

Basic net (loss) income per share

$(0.07)

$0.00

Diluted net (loss) income per share

$(0.07)

$0.00

6.ACCOUNTS RECEIVABLE

A summary of accounts receivable is as follows:

March 31, 2018

December 31, 2017

Trade receivables

$11,901,408 

$14,451,899 

Unbilled revenue, net and unapplied advances

(1,281,946)

(1,081,525)

Allowance for doubtful accounts

(42,175)

(106,551)

Total accounts receivable, net

$10,577,287 

$13,264,323 

7.DEFERRED COMMISSIONS

Our incremental costs of obtaining a contract, which consist of sales commissions, are deferred and amortized over the period of contract performance. Effective January 1, 2018, when we adopted the modified retrospective method of the new revenue recognition pronouncement, we increased deferred commissions by $879,666 with a corresponding increase in beginning retained earnings. Deferred commissions are included in prepaid and other current assets in our consolidated balance sheets. As of March 31, 2018, we had $849,975 related to unamortized deferred commissions. We had $151,308 and $154,642 of commissions expense for the three months ended March 31, 2018 and 2017, respectively. If we had recognized commissions expense under the full retrospective approach, commission expense would have been $164,419 for the three months ended March 31, 2017.


12



8.INTANGIBLE ASSETS

Intangible assets are amortized over expected useful lives ranging from 1.5 to 10 years and consist of the following:

March 31, 2018

December 31, 2017

Gross

Carrying

Amount

Accumulated

Amortization

Accumulated

Impairment

Gross

Carrying

Amount

Accumulated

Amortization

Accumulated

Impairment

Delphiis, Inc.

Acquired technology

$900,000

$(246,253)

$(547,484)

$900,000

$(242,002)

$(547,484)

Customer relationships

400,000

(233,257)

(166,743)

400,000

(233,257)

(166,743)

Trademarks

50,000

(50,000)

50,000

(50,000)

Non-compete agreements

20,000

(17,292)

(2,708)

20,000

(17,292)

(2,708)

 Total Delphiis, Inc.

$1,370,000

$(546,802)

$(716,935)

$1,370,000

$(542,551)

$(716,935)